Argentine Leader Vows to Retain Currency Peg to Dollar

By CLIFFORD KRAUSS

Published: September 14, 1998

BUENOS AIRES, Sept. 13—
It has become almost a daily ritual. President Carlos Saul Menem and his chief economic advisers take every opportunity to promise that they will not retreat from the Government's fixed exchange rate that pegs the value of the Argentine peso to the American dollar one to one.

Such pronouncements have often preceded huge devaluations in Latin America.

But most Argentine economists and Wall Street analysts are taking President Menem at his word, at least for now, despite concerns that the currency peg could push up interest rates and unemployment.

''I think it will hold,'' said Jorge O. Mariscal, chief investment strategist for Latin America at Goldman, Sachs. Before devaluing, Mr. Mariscal said, Argentina would, in a severe crisis, probably ''dollarize'' its economy as Panama has for decades -- replacing its currency with dollars.

In part, the cautious optimism that Argentina will not have to devalue comes from the slight strengthening in the Japanese yen in recent weeks. That has relieved concerns that China will have to devalue, which in turn has helped Hong Kong sustain its currency peg to the American dollar. But if the yen slides again, or the Brazilian real suddenly collapses, Argentina could face deep financial trouble.

''At this point the only way I could foresee a change is if capital flight were so massive it would mean everyone would convert their pesos into dollars,'' said Martin Redrado, a former Menem adviser who runs an economic research center here. ''But so far the Argentine banks have weathered this crisis very well.''

Indeed, the Argentine program has attracted global attention recently, with Indonesia and Russia considering similar policies. Indonesia rejected a peg to the dollar while Russia has yet to adopt a rescue plan.

All five presidential candidates vying to replace Mr. Menem in elections next year have promised not to replace the peg because of fears that a change of policy could mean a return to economic mismanagement.

Faced with an inflation rate of 2,300 percent and a run on the banks, President Menem installed the currency peg in 1991. Within weeks, the inflation rate plummeted and has stabilized at around 1 percent in the last three years.

Currency stability and an aggressive Government program of privatizing public agencies drew a flood of foreign investment, which in turn stimulated strong economic growth rates that peaked at 8 percent last year.

The currency peg is set by a law that prohibits the Government from printing new pesos unless they are backed by dollars or gold reserves in the central bank. Other laws require private banks to keep 25 percent of their reserves in the central bank. And as added insurance, the Government has negotiated lines of credit with a number of investment banks, including Goldman, Sachs; Morgan Stanley and Lehman Brothers.

Despite the growing economic crisis in Venezuela and Brazil, the Argentine Government reports that it has $24.5 billion in reserves in the central bank, slightly more than the total amount of pesos in circulation. Even more impressive, local economists note, is that private bank deposits actually grew last month by five-tenths of a percent despite the bad news from Asia and Russia.

''The tangible economic gains from the convertibility program argue heavily in favor of retention of convertibility despite any ill consequences,'' said Lawrence Goodman, chief economist at Santander Investment, the investment banking arm of Banco Santander.

Mr. Goodman noted that when faced with a similar economic crisis after the Mexican devaluation in 1994, President Menem did not budge from the peg despite rising interest rates and an unemployment rate that climbed as high as 18 percent. Unemployment has since fallen to 14.2 percent.

Still, convertibility has a price. Since it is linked to a strong dollar, Argentine exports are expensive and are dropping. According to the latest Government statistics, Argentina's trade deficit in July climbed to $741 million, more than double the amount of the month before. Since 30 percent of Argentina's trade is with Brazil, a devaluation and deepening recession there over the next several months would only make the Argentine deficit grow faster.